Greg's Tasty Ice Cream is considering building a new ice cream factory that costs $8.3 million.The company accountants believe that,not accounting for interest costs,building the factory will increase profits by $5 million the first year,$4 million the second year and have no value thereafter.Greg's Tasty Ice Cream should build the factory if the interest rate is
A)3% but not if it is 4%.
B)4% but not if it is 5%.
C)5% but not if it is 6%.
D)6% but not if it is 7%.

Question

Quizplus · Accepted Answer

To determine if building the new factory is worth it, we need to calculate the net present value (NPV) of the project. NPV gives us the value of the project in today's dollars, accounting for the time value of money.

NPV = -Initial Investment + (Cash Flow Year 1 / (1 + Interest Rate) ^ 1) + (Cash Flow Year 2 / (1 + Interest Rate) ^ 2)

NPV = -8.3 + (5 / 1.05) + (4 / 1.05^2)

NPV = -8.3 + 4.76 + 3.76

NPV = 0.22

If the interest rate is 5% or lower, the NPV is positive, meaning the project is profitable. Therefore, the company should build the new factory if the interest rate is 5% but not if it is 6% or higher.

The correct answer is C: 5% but not if it is 6%.

Greg's Tasty Ice Cream Is Considering Building a New Ice